Chapter 12Cash Flow Estimation and Risk AnalysisLearning ObjectivesAfter reading this chapter, students should be able to:Identify “relevant” cash flows that should and should not be included in a capital budgeting analysis.Estimate a project’s relevant cash flows and put them into a time line format that can be used to calculate a project’s NPV, IRR, and other capital budgeting metrics.Explain how risk is measured and use this measure to adjust the firm’s WACC to account for differential project riskiness.Discuss how some projects can be altered after they have been accepted and how these alterations can change a project’s cash flows and thus its realized NPV.Describe the post-audit, which is an important part of the capital budgeting process, and discuss its relevance in capital budgeting decisions.Chapter 12: Cash Flow Estimation and Risk AnalysisLearning Objectives43

This
preview
has intentionally blurred sections.
Sign up to view the full version.

Lecture SuggestionsThis chapter covers some important but relatively technical topics. Note too that this chapter is more modular than most, i.e., the major sections are discrete, hence they can be omitted without loss of continuity. Therefore, if you are experiencing a time crunch, you could skip sections of the chapter.What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 12, which appears at the end of this chapter solution. For other suggestions about the lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our classes.DAYS ON CHAPTER: 4 OF 58 DAYS (50-minute periods)44Lecture SuggestionsChapter 12: Cash Flow Estimation and Risk Analysis

Answers to End-of-Chapter Questions12-1Only cash can be spent or reinvested, and since accounting profits do not represent cash, they are of less fundamental importance than cash flows for investment analysis. Recall that in the stock valuation chapter we focused on dividends, which represent cash flows, rather than on earnings per share.12-2Capital budgeting analysis should only include those cash flows that will be affected by the decision. Sunk costs are unrecoverable and cannot be changed, so they have no bearing on the capital budgeting decision. Opportunity costs represent the cash flows the firm gives up by investing in this project rather than its next best alternative, and externalities are the cash flows (both positive and negative) to other projects that result from the firm taking on this project.

This
preview
has intentionally blurred sections.
Sign up to view the full version.